Virgin America Looks to IPO in 2014 but JetBlue Poses a Challenge

Virgin America derives two-thirds of its profit from cross-country flying, where JetBlue will introduce an upgraded product.

SAN FRANCISCO ( TheStreet) -- The trans-continental aviation market is a tough one, but it has been good to Virgin America -- good enough that the carrier is considering an initial public offering next year.

Soon, however, Virgin America will face a new challenge from JetBlue ( JBLU) which will introduce its new approach to trans-continental routes in June 2014. That approach will include first class for the first time in JetBlue's history, as well as upgraded coach accommodations on A321 jets newly introduced to its fleet.

Virgin America, which has two-thirds of its capacity in California-East Coast markets, expects to report a third-quarter profit after saying that the quarter ended June 30 was the first profitable quarter since it began flying in August 2007. Second-quarter net income was $8.8 million on revenue of $376 million. Revenue per available seat mile grew by 7.8%, the best in the industry, despite flat capacity. For the first six months, Virgin America lost $38 million.

"Trans-con is our most profitable market, the core strength of our airline," said CEO David Cush, in an interview. The carrier flies from San Francisco and Los Angeles to Boston, New York, Philadelphia and Washington. Cush said the John F. Kennedy International Airport routes are the most profitable. Two-thirds of the airline's profit is derived from trans-con flying, to which it devotes two-thirds of its capacity.

"The brand is a good brand, (popular) in high income urban markets where product is important" on five and six hour long trans-con flights, Cush said. Virgin America is known for amenities including Wi-Fi, leather seats, mood lighting and advanced in-flight entertainment.

Cush said he isn't fazed by JetBlue's announcement last week that it will upgrade its trans-con service, even though in many respects the two airlines would seem to be close competitors. Both combine high amenity levels and low fares on narrow-body Airbus jets flown primarily out of gateway airports. JetBlue carries the most passengers at JFK, while Virgin America is the second-biggest carrier at San Francisco International Airport. (Virgin is also sixth at JFK.)

"JetBlue is a great airline with a great product, just as we are," Cush said. "But it's a question of whether you can create a first-class product and first-class service in a small percentage of your markets." JetBlue's new Mint product would be offered initially on 16 seats on trans-con flights from New York. "We have first class in all our markets," Cush said. "It's not as simple as throwing a lie-flat seat on your plane and calling it a first-class product."

Additionally, he said, "We've had Wi-Fi for years and they are still six months away."

In the first quarter of 2013, American ( AAMRQ) had nine daily flights between Kennedy and Los Angeles International Airport, while Delta ( DAL) had seven, United ( DAL), six, Virgin America had five and JetBlue had four. Virgin America has eight first-class seats on its aircraft, fewer than the majors, and 138 coach seats.

"We make our living off coach," Cush said. First-class passengers either pay about $2,000 per seat or pay $400 for an upgrade; none get free upgrades.

Travel analyst Henry Harteveldt of Hudson Crossing said JetBlue poses a threat to Virgin America. "I was pleased when I saw Virgin America announce a profit for the second quarter, and hopefully they will report meaningful profits in the future," Harteveldt said. "But JetBlue poses more of a challenge to Virgin America than any network airline does."

JetBlue's advantages, Harteveldt said, will include more legroom in coach class, free Wi-Fi in coach, and 100 free TV channels compared to 24 on Virgin America. He said that if JetBlue's new service is successful, it is likely to be added in the Boston-California markets that JetBlue already serves.

Virgin America's second-largest market is West Coast flying, which accounts for about 20% of capacity.

In the next few weeks, Virgin America will release third-quarter results that Cush called "very healthy;" he also projects "a healthy margin" in the fourth quarter. If the fourth-quarter projections turn out to be accurate, and if the carrier can break even in the first quarter of 2014, an IPO is likely. Currently, Virgin America's principal owner is New York hedge fund Cyrus Capital, with about 50%; Richard Branson's Virgin Group has about 46%.

"Market conditions seem to be reasonably good right now, but we need to hit a few markers before we go public," Cush said. "The first quarter has historically been our Achilles' heel, but we reduced our loss in the first quarter of 2013 and hopefully we can make it the rest of the way there in 2014. That's the biggest marker we have out there. If we turn the corner in the first quarter, we position this company to go out (to the public markets)."

A key move for the carrier was to suspend aircraft acquisition earlier this year. Between the second quarter of 2010 and the second quarter of 2012, the carrier took delivery of 25 Airbus A320 family aircraft. Now, with the fleet at 53 planes, deliveries have been curtailed until 2015. Again, the course recalls a similar move by JetBlue, which slowed its rapid growth in the late 2000s.

"Slowing down has allowed us to mature," Cush said. "It provides a nice breather for the company; we will start to grow again in the second half of 2015."

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